Fifth Third Bank 2003 Annual Report Download - page 70

FIFTH THIRD BANCORP AND SUBSIDIARIES
68
Management’s Discussion and Analysis of
Financial Condition and Results of Operations
Off-Balance Sheet and Certain Trading Activities
The Bancorp consolidates all of its majority-owned subsidiaries. Other
entities, including certain joint ventures, in which there is greater than
20% ownership, but upon which the Bancorp does not possess, nor
cannot exert, significant influence or control, are accounted for by
equity method accounting and not consolidated; those in which there
is less than 20% ownership, but upon which the Bancorp does not
possess nor cannot exert, significant influence or control are generally
carried at cost.
The Bancorp does not participate in any trading activities
involving commodity contracts that are accounted for at fair value. In
addition, the Bancorp has no fair value contracts for which a lack of
marketplace quotations necessitates the use of fair value estimation
techniques. The Bancorp’s derivative product policy and investment
policies provide a framework within which the Bancorp and its
affiliates may use certain authorized financial derivatives as an
asset/liability management tool in meeting the Bancorp’s ALCO
capital planning directives, to hedge changes in fair value of its largely
fixed rate MSR portfolio or to provide qualifying customers access to
the derivative products market. These policies are reviewed and
approved annually by the Audit Committee and the Board of
Directors.
As part of the Bancorp’s ALCO management, the Bancorp may
transfer, subject to credit recourse, certain types of individual financial
assets to a non-consolidated QSPE that is wholly owned by an
independent third party. In 2003 and 2002, certain primarily fixed-
rate short-term investment grade commercial loans were transferred to
the QSPE. Generally, the loans transferred, due to their investment
grade nature, provide a lower yield and therefore transferring these
loans to the QSPE allows the Bancorp to reduce its exposure to these
lower yielding loan assets and at the same time maintain these
customer relationships. These individual loans are transferred at par
with no gain or loss recognized and qualify as sales, as set forth in
SFAS No. 140. At December 31, 2003, the outstanding balance of
loans transferred was $1.8 billion. Given the investment grade nature
of the loans transferred, as well as the underlying collateral security
provided that includes commercial real estate, physical plant and
property, inventory, receivables, cash and marketable securities, the
Bancorp does not expect this recourse feature to result in a significant
use of funds in future periods or losses and therefore, the Bancorp has
not maintained any loss reserve related to these loans transferred.
The Bancorp utilizes securitization trusts formed by independent
third parties to facilitate the securitization process of residential
mortgage loans and certain floating rate home equity lines of credit. As
previously discussed, during 2003, the Bancorp securitized and sold
$903 million in home equity lines of credit to an unconsolidated
QSPE that is wholly owned by an independent third party. See Note
21 of the Notes to Consolidated Financial Statements for additional
detail. The cash flows to and from the securitization trusts are
principally limited to the initial proceeds from the securitization trust
at the time of sale with subsequent cash flows relating to retained
interests. The Bancorp’s securitization policy permits the retention of
subordinated tranches, servicing rights, interest-only strips, residual
interests, credit recourse, other residual interests and, in some cases, a
cash reserve account. At December 31, 2003, the Bancorp had
retained servicing assets totaling $299 million, an interest-only strip
totaling $1 million, subordinated tranche security interests totaling
$55 million and residual interests totaling $32 million.
The accounting for QSPE’s is currently under review by the FASB
and the conditions for consolidation or deconsolidation of such
entities could change.
The Bancorp had the following cash flows with these
unconsolidated QSPE’s for the year ended December 31:
Table 28–Cash Flows with Unconsolidated QSPE’s
($ in millions) 2003 2002
Proceeds from transfers, including new
securitizations . . . . . . . . . . . . . . . . . . . . $1,345 258
Proceeds from collections re-invested in
revolving-period securitizations . . . . . . . $46 —
Transfers received from QSPE . . . . . . . . . $ 116 270
Fees received . . . . . . . . . . . . . . . . . . . . . . $25 26
At December 31, 2003, the Bancorp had provided credit recourse
on approximately $559 million of residential mortgage loans sold to
unrelated third parties. In the event of any customer default, pursuant
to the credit recourse provided, the Bancorp is required to reimburse
the third party. The maximum amount of credit risk in the event of
nonperformance by the underlying borrowers is equivalent to the total
outstanding balance of $559 million. In the event of nonperformance,
the Bancorp has rights to the underlying collateral value attached to
the loan. Consistent with its overall approach in estimating credit
losses for residential mortgage loans held in its loan portfolio, the
Bancorp maintains an estimated credit loss reserve of approximately
$14 million relating to these residential mortgage loans sold.
Through December 31, 2003, the Bancorp, through its
electronic payment processing division, processed approximately
89.3 billion of VISA®and MasterCard®merchant card transactions.
Pursuant to VISA®and MasterCard®rules, the Bancorp assumes
certain contingent liabilities relating to these transactions which
typically arise from billing disputes between the merchant and
cardholder that are ultimately resolved in the cardholder’s favor. In
such cases, these transactions are “charged back” to the merchant
and disputed amounts are credited or refunded to the cardholder. In
the event that the Bancorp is unable to collect these amounts from
the merchant, it will bear the loss for refunded amounts. The
likelihood of incurring a contingent liability arising from
chargebacks is relatively low, as most products or services are
delivered when purchased, and credits are issued on returned items.
For the year ended December 31, 2003, the Bancorp processed
approximately $109 million of chargebacks presented by issuing
banks resulting in actual losses to the Bancorp of approximately $4
million. The Bancorp accrues for probable losses based on historical
experience and has recorded an estimated credit loss reserve of
approximately $1 million at December 31, 2003.
Fifth Third Securities, Inc (FTS), a subsidiary of the Bancorp,
guarantees the collection of all margin account balances held by its
brokerage clearing agent for the benefit of FTS customers. FTS is
responsible for payment to its brokerage clearing agent for any loss,
liability, damage, cost or expense incurred as a result of customers
failing to comply with margin or margin maintenance calls on all
margin accounts. The margin account balance held by the brokerage
clearing agent as of December 31, 2003 was $51 million. In the
event of any customer default, FTS has rights to the underlying
collateral provided. Given certain FTS margin account relationships
were in place prior to January 1, 2003 and the existence of the
underlying collateral provided as well as the negligible historical
credit losses, FTS does not maintain any loss reserve.